This paper evaluates the predictive performance of machine learning techniques in estimating time-varying betas of US stocks. Compared to established estimators, tree-based models and neural networks outperform from both a statistical and an economic perspective. Random forests perform the best overall. Machine learning-based estimators provide the lowest forecast errors. Moreover, unlike traditional approaches, they lead to truly ex-post market-neutral portfolios. The inherent model complexity is strongly time-varying. The most important predictors are various historical betas as well as fundamental turnover and size signals. Compared to linear regressions, interactions and nonlinear effects enhance the predictive performance substantially.
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Machine learning-based market beta estimators outperform established benchmark models both statistically and economically. Analyzing the predictability of time-varying market betas of U.S. stocks, we show that machine learning-based estimators produce the lowest forecasting and hedging errors. They also help create better market-neutral anomaly strategies and minimum variance portfolios. Among the various techniques, random forests perform best overall. Model complexity is highly time-varying. Historical betas, turnover, and size are the most important predictors. Compared to linear regressions, allowing for nonlinearity and interactions significantly improves the predictive performance.